Private Equity Rushes Into China Technology

Since Intel Capital first came to China in 1998, it hasn’t slowed down, investing $650 million in more than 100 companies, including Internet portals Sohu.com (SOHU) and Phoenix New Media (FENG), and Neusoft (600718), China’s largest IT solutions company. Last year alone, the investing arm of Intel (INTC) in Santa Clara, Calif., put $90 million into 13 Chinese companies, more than 15 percent of the total investment it made globally, making China its No. 2 market after North America.

“We are excited about the opportunity, the growth prospects, and entrepreneurship in this country,” says Arvind Sodhani, president of Intel Capital and executive vice president of Intel Corp., in an interview March 28 in Beijing. “We will be looking at China as our largest market going forward.” Already, more than half of Intel Capital’s investment is overseas, with India in third place for total investment, behind North America and China, and Brazil, Russia, and Turkey among other key markets.

Where’s the money going? Intel has been seeking innovative companies in all areas of the Internet, including cloud computing, mobile Web, e-commerce, and software and services, says Sodhani, a 30-year veteran of Intel who has led its investing arm since 2005. Most recent investments: Beijing Cloud Union, an online gaming company, and Fashion Republic, an Internet fashion photo-sourcing platform, both of which Intel bought into in January.

Intel has a lot of competition in China’s soaring venture capital and private equity markets. A total of $27.6 billion was plowed into 695 investments in China last year, up 166 percent and 92 percent, respectively, over 2010, according to Zero2IPO Group, a venture capital and private equity research agency in Beijing. “The year 2011 witnessed a sharp growth in PE investments,” wrote Fiona Fu, a senior analyst at Zero2IPO, in a January 5 report.

Last year, the machinery manufacturing industry came in first, with 61 deals closed, followed by chemical raw materials and processing with 56 deals, then bio and health care at No. 3, with 55, according to the research firm. The Internet sector, with 44 deals closed, was the fifth most active but came in third in value, with $2.5 billion invested. More money went to the financial sector than any other, with $4.9 billion invested.

That money is coming from an estimated 8,000 private equity firms, double the number in China three years ago, estimates Chang Sun, managing director at Warburg Pincus in Hong Kong. “You have PE firms knocking on doors of private enterprises, saying, do you want money? Do you want private equity? It’s scary,” says Sun, speaking at SuperReturn China 2012, a private equity forum in Beijing on March 27. “And their whole strategy is, can you go public in three years? That’s all they are concerned about.”

“I have heard even bigger numbers. Some say there are 20,000 firms. I would be happy with 8,000,” says Jonathan Zhu, managing director at Bain Capital Asia, speaking at the private equity forum. “If all you bring is money, then you are not in a great position. China is now one of the great exporters of capital, so that cannot be your competitive differentiation.”

One unusual characteristic: Many private equity and venture capital firms have a government connection and were started by local Chinese officials. That’s usually not a good thing for foreign firms eager to win deals, says Howard Chao, a senior partner in the Asia practice at O’Melveny & Myers. “That is one of the gorillas in the room for PE in China—how do you compete on big deals if your competitor is one of China’s favored children of the state?” says Chao. “It means it might not be an even playing field.”

Intel Capital aims to offer Chinese startups the technological resources and global business relationships of its parent, says Sodhani. Through a program launched last year called Intel Capital Technology Days, he has been able to introduce startup companies to such multinationals as Daimler-Benz (DAI), BMW, Microsoft (MSFT), and Huawei Technologies. “We are not just about capital. Startup companies need to find customers, get technology, get management help, and learn from the experiences of people [who] have done this before. Our value proposition is unique,” says Sodhani.

Don't expect China to unseat the U.S. soon, however: 49 percent of global investment last year still went to the U.S. and Canada combined, Sodhani says. "The number of investment oppotunities we see in the U.S. is driven by the fact hat the ecosystem is ectremely developed there. It will take a while for China to present that many opportunities on an ongoing basis. We see a lot of business plans here, but we don't take them all," says Sodhani. "The ecosystem is still evolving in China, and it takes years to develop. [Venture capital] didn't grow up in the U.S. overnight."